Arthrocare Device Use Draws More Scrutiny

OKLAHOMA CITY -- An escalating FBI probe could pose new threats to embattled Arthrocare ( ARTC).

This month, the National Insurance Crime Bureau issued an alert to Florida insurers about a mounting FBI investigation into minor -- but lucrative -- surgeries that often require one of Arthrocare's most popular devices.

Moreover, sources say, a federal grand jury is preparing to examine the matter as well.

Sales of Arthrocare's popular Perc-D SpineWands, which have fueled the company's explosive growth in recent years, could suffer as a result.

According to the NICB alert, FBI officials in West Palm Beach, Fla. are seeking information about "percutaneous discectomy" surgeries performed on patients covered by pending legal settlements rather than traditional health insurance. Investigators are focusing on discectomies billed under a special code -- known as CPT 63056 -- that can bring especially generous payments.

"Some federal criminal investigations like this can take years," says Gary Roberts, a Florida attorney familiar with this particular case. "However, from every indication I've seen, this one appears to be fast-tracked."

Palm Beach Lakes performs numerous discectomies on car-wreck victims and often bills for them under the generous 63056 procedure code. Car insurers, faced with huge payment demands from law firms representing the patients, ultimately foot the bill.

Lately, however, the nation's largest car insurance companies -- including AllState ( ALL), AIG ( AIG), Progressive ( PGR) and State Farm -- have started to fight back. They feel that some surgery centers, such as Palm Beach Lakes, have been charging excessive payments for percutaneous discectomies that patients don't even need. They routinely challenge the cases in court as a result.

Now, the FBI is asking Florida insurers to turn over the "demand packages" and "demand letters" they received for those operations. The agency is requesting questionable claims submitted by several law firms for procedures performed at one surgery center in particular.

In the NICB notice obtained by TheStreet.com -- which announces a "high-exposure, multi-carrier, multi-claim investigation" -- the names of the law firm and the surgery center have been redacted. However, outside sources have confirmed that Palm Beach Lakes is indeed the surgery center under review.

Palm Beach Lakes has close ties to Arthrocare: It ranks as a major Arthrocare customer that buys large volumes of the company's $7,500 SpineWands. But the surgery center has helped the company out in other important ways as well.

One of the surgeons there trains doctors wanting to use Arthrocare's SpineWands, and another sold Arthrocare a firm that secures reimbursement for the devices.

"I wrote their (Arthrocare's) protocol, or I revised most of their protocol," Palm Beach Lakes spine surgeon Jeffrey Kugler has explained in the past. "Anyone who wants to do this procedure in the country needs to basically come here and make sure they are doing it appropriately ... We have written the training documentation."

Kugler offered that information when being questioned in a deposition carried out by AllState two years ago. By now, Kugler has faced multiple courtroom challenges from car insurance companies that portray him as one of the most prevalent users of percutaneous discectomies -- with some of the highest prices -- in the country.

Kugler can thank CPT Code 63056 for some of his riches. Using that code, Kugler has picked up tens of thousands of dollars -- more than the listed price for brain surgery -- for minor operations that take no more than a half-hour of his time.

Notably, Arthrocare has promoted the use of that code in its own presentations. In documents obtained by TheStreet.com, Arthrocare's national sales trainer specifically states that she would "skim over 62287" -- the proper code for Perc-D surgeries -- and "focus on 63056" when marketing the company's SpineWands to physicians.

She talks at length about an outfit called DiscoCare as well.

Jonathan Cutler, another physician at Palm Beach Lakes, launched DiscoCare a few years ago. The company supplies Arthrocare's SpineWands to surgery centers and then seeks reimbursement from insurers on their behalf.

Since traditional health insurers consider percutaneous discectomties experimental -- and often refuse to pay for the procedures -- DiscoCare has focused on nontraditional payers instead. By concentrating on personal injury cases, in particular, DiscoCare has enjoyed phenomenal success.

Arthrocare ultimately bought DiscoCare from Cutler for $25 million late last year. While that deal has since backfired, it sparked some grand plans at the time.

"This is another milestone in Arthrocare's continued growth, as we continue to bring in-house those capabilities critical to our future," Arthrocare CEO Michael Baker boasted when announcing the transaction this January. "This acquisition will significantly enhance our capabilities to support all of our businesses with a reimbursement service offering" down the road.

By purchasing DiscoCare -- and then expanding its reach -- some feel that Arthrocare has invited serious trouble instead.

"Because of its acquisition of DiscoCare and its prior disclosures regarding marketing 'our DiscoCare model,' Arthrocare has placed itself in the middle of what appears to be a major investigation by the FBI into potential billing fraud," says one Arthrocare investor who has sold the company's stock short in anticipation of a fall. "Investors should now ask themselves this: Is Arthrocare an unintentional facilitator to what may be a multi-hundred-million-dollar insurance fraud, or is it a full accomplice?"

Arthrocare declined to comment for this story. In the past, however, the company has repeatedly proclaimed its innocence and that of DiscoCare.

It has stirred up suspicions, nonetheless.

Even before the FBI started seeking their help, car insurers were scrutinizing the so-called "DiscoCare model." Indeed, one of them had subpoenaed Arthrocare's leading executives -- including its CEO and its spine chief -- in an effort to prove that the DiscoCare model is actually a massive insurance scam.

Those subpoenas came shortly after Arthrocare purchased DiscoCare and officially took control of the company. Since then, Arthrocare has gone on to announce a looming restatement due to improper transactions with DiscoCare and some other firms that seem to resemble it.

News of the restatement sent the stock reeling; shares were recently up 3.6% to $27.35.

By then, SIG Susquehanna analyst David Turkaly had already downgraded Arthrocare twice and adopted a negative view of the company's stock even though his firm still owned the shares. Turkaly, for one, has worried about DiscoCare from the start.

"As questions arose regarding the acquisition, management responded to investor concerns by stating that there was nothing unusual going on within the DiscoCare unit, and these were traditional business practices that were very common in the industry," Turkaly wrote last month, following news of the planned restatement. But "if DiscoCare's business practices were in fact very common in the industry, we are left to wonder: Why was the accounting of this relationship and subsequent transaction so difficult to get right?

"Here we are yet again, with more controversy surrounding the now-infamous DiscoCare."